Friday, August 18, 2006

(Fair)Tax Evasion

This is a letter i received from Karen Walby, Director of Research for AFFT. She is a brilliant woman, and I love reading her responses to questions and concerns.

I plan on making this blog a bit more organized soon. I just need to learn how to create folders and sub-folders in the language this site uses. If anyone knows how, shoot me a line please!

I want to categorize all my blogs and any articles, letters, or comments I find into areas of interest.

Question: Since business purchases are not taxable, how does the FairTax keep
individuals from pretending to have a business so they can buy things tax-free?

Answer: Under the FairTax the entire income tax code is repealed and along with it the various designations of subchapter S corporations or C corporation. There would be no longer be a tax reason to incorporate or not to incorporate.

Under the FairTax, any business can purchase goods & services for business purposes tax free if they meet certain criteria and certain responsibilities which are explained in the paragraphs below.

The FairTax has several features that make it difficult and very risky for persons to have a scam business in order to purchase items tax-free. First, in order for any person to purchase items tax-free for business purposes, the business has to be a registered business and possess a registered business certificate issued by the state sales tax authority. Registered businesses will be expected to file monthly or quarterly sales tax returns with the state if retail sales are made. The registered business certificate will enable the business to purchase tax-free from wholesale vendors, but the wholesale vendor must retain a copy of the registration certificate to justify not having collected tax on the sale. When a business purchases items for business use from a retail vendor, it will have to pay the tax on the purchase and take a credit against the tax due on their monthly sales tax return. If the business has no retail sales it will receive a cash refund. The business must keep invoices/receipts to document what it purchased, the amount of the purchase, and the business purpose.

Also, registered businesses will be subject to the possibility of being audited by the state sales tax authority. During such an audit they will have to produce the invoices for all the "business purchases" that they did not pay sales tax on, and will have to be able to show that they were bona fide business expenses. If they cannot prove this, then they will have to pay the taxes that should have been paid when the items were purchased, plus interest, and penalties. The probability of being audited will be much greater than it is under the current system with its over 140 million tax filers. Under the FairTax, there will be less than 20 million businesses who will be filing sales tax returns and thus subject to the possibility of being audited. Thus the probability of tax cheats getting caught will be much greater than it is today, making tax evasion riskier than it is today. Additionally, while the FairTax has much stronger taxpayer rights than does the current tax system, the FairTax legislation provides for a number of fines and penalties for non-compliance. It also authorizes a mechanism for reporting tax cheats and obtaining a reward. An example would be

Another potential scam is to have a “fake” family business in order to buy things for family members tax-free. The FairTax has a specific provision to prevent this. Although it does not prohibit businesses from providing taxable property or services as gifts, prizes, rewards or as remuneration for employment; the gift, reward, etc. is considered to be the conversion of property or services from business use to personal use and therefore taxable. Likewise, there is a similar provision to prevent abuse of employee discounts. Under the FairTax, employer-provided employee discounts over 20 percent are taxable. The term “employee discount” means an employer’s offer of taxable property or services for sale to its employees or their families for less than the offer of such taxable property or services to the general public. If the employee discount amount exceeds 20 percent of the price to the general public, then the sale of such taxable property or services by the employer to the employee is considered the conversion of property or services to personal use and subject to tax. The taxable amount is the amount by which the discount exceeds 20 percent of the price to the general public.

Karen Walby

Director of Reasearch, Ph.D.

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